Punishment or Pushback: Financial Regulation in the Midst of Recession

Nearly one American in two is currently “financially fragile” – unable, that is, to come up with $2000 dollars in 30 days to deal with an unexpected emergency.[1] That fragility presumably does not stretch out to the fortunate few employed by Goldman Sachs, collectively the recipients of the reportedly $15.4 billion set aside by the Wall Street giant for the payment of bonuses at the end of 2010.[2] Fifteen point four billion dollars averages out at $435,000 per Goldman Sachs employee: in a year in which, far away from Wall Street, one million homes were foreclosed[3] and 15 million Americans went without employment, let alone bonuses.[4] While mainstream America continues to struggle with the recessionary consequences of a meltdown caused by financial excess, large financial institutions have left that struggle far behind. They are back to profitability and back to their old ways. Senior bankers are making money again while the rest of us are not.[5]

There was a time, not so very long ago, when things were otherwise: when leading Wall Street players publicly conceded (and indeed apologized for) the causal role played by their institutions in the financial meltdown of 2008. There was a time when the energies of Congress were accordingly focused on the creation of stronger regulatory structures designed to block a repetition of that meltdown. There was even a time when some of the minor players in the debacle of 2008 found themselves in court, charged with fraud. But those apologies were brief. The new regulatory structures were born flawed; [6] and the few prosecutions failed to deliver.[7] To a truly remarkable degree, given the scale and longevity of the damage they have caused, the guilty have escaped unpunished from the financial crisis of 2008, as Washington has turned its attention elsewhere, in the process allowing bank lobbyists to water down even the modest reforms imposed at the height of the crisis. Washington, that is, except Carl Levin and his subcommittee. Their Wall Street and the Financial Crisis report [8] deserves to be compulsory reading for every concerned citizen, for it reaffirms what we already knew – that regulation and even punishment, certainly not pushback, remains essential if the practices which generated such economic havoc and social misery in 2008 are not eventually to do the same again on an even grander scale.

A little recap would not go amiss, given the amount of money, energy and argumentation now flowing into the weakening of new regulatory constraints on the behavior of leading U.S. financial institutions.Lest we forget, remember this.

The credit crisis of 2008 was caused by inadequately-regulated and over-confident U.S. financial institutions, within which there were serious lapses of accountability and ethics. This is the well-established conclusion of a welter of both academic and journalistic reports on the events and processes leading up to the collapse of Lehmann Brothers in September 2008, and the subsequent financial meltdown.[9] The credit crisis was the product of recklessness, corruption, managerial failure, greed and arrogance – in what Michael Mayo called “an industry on steroids.”[10] That is also the conclusion reached by the subpoena-empowered Financial Crisis Inquiry Commission in its January 2011 report. Among the Commission’s findings were these: that “widespread failures in financial regulation and supervision proved devastating to the stability of the nation’s financial markets;” that “dramatic failures of corporate governance and risk management at many systemically important financial institutions were a key cause of this crisis;” and that “a combination of excessive borrowing, risky investments, and lack of transparency put the financial system on a collision course with crisis.”[11]

To prevent an even deeper crisis, leading financial institutions received huge amounts of taxpayer and Federal Reserve support, without which many of them would undoubtedly have folded. We now know, because of Bernie Sanders’ diligence, thatin addition to TARP moneyGoldman Sachs received nearly $600 billion in loans and other financial aid from the Federal Reserve in the wake of the crisis, “Morgan Stanley…received nearly $2 trillion, Citigroup…$1.8 trillion, Bear Stearns…$1 trillion, and Merrill Lynch…some $1.5 trillion in short term loans from the Fed.”[12] Even hedge fund giants like John Paulson apparently “took their cut of the Fed’s emergency cash.”[13] But though rapidly saved in this fashion by this staggering volume of tax-payer dollars and Fed loans, the big six financial institutions now sitting astride Wall Street – Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley and Wells Fargo – failed miserably to pass on their good fortune with equal speed to either struggling small banks [14] or to a Main Street suddenly bereft of available credit. [15]

The fallout from the crisis created by bad financial practices continues unabated: primarily in the form of extensive job loss, unprecedented levels of home foreclosure, and now serious cuts in state-level public services. As Simon Johnson has recently noted, “employment remains more than 5 percent below its pre-crisis peak, millions of homeowners are still underwater on their mortgages, and the negative fiscal consequences – at national, state and local level – remain profound.”[16] Indeed we may be facing such a prolonged recession as a result of the 2008 financial collapse as to effectively lose a whole decade, even perhaps a whole generation. Certainly there are disturbing signs in the wind of new and awesome problems ahead: not least persistent and unexpected unemployment among the estimated 85 percent of the 2 million new college graduates likely to return home in 2011 for want of adequate work![17]

Bankers did initially concede responsibility and invite some degree of regulatory reform. Bank of America chief executive and president Brian Moynihan told the opening session of the Financial Crisis Inquiry Commission that “over the crisis, we as an industry caused a lot of damage;” and JP Morgan Chase’s Jamie Dimon admitted before the same body that “we did make mistakes and there were things we could have done better.”[18] Appearing before a parliamentary committee in London a month later, the former chairman of HBOS made similar concessions, saying that he was “profoundly and unreservedly sorry.” John Mack of Morgan Stanley even called the crisis “a profound wake up call for [his] firm;” and all four bankers appearing before the Financial Crisis Inquiry Commission declared their willingness to co-operate with tighter oversight while indicating their fear that such oversight might become excessive. It didn’t last of course. By the time of the next Davos conference, Jamie Dimon for one was already condemning ‘the incessant broad-based vilification of the banking industry” as both unfair and damaging. Fortunately for the rest of us, the French President did not agree, reminding the American banker that “the world has paid with tens of millions of unemployed, who were in no way to blame and who paid for everything.”[19] Nicholas Sarkozy had a point.

The appropriateness of that admission of responsibility was confirmed by later bipartisan investigatory panels, particularly Carl Levin’s. The suspicion that even major players in the industry misbehaved prior to the crisis is now evident for all to see from the evidence presented in the Levin report. As the Senator put it, the investigation of his sub-committee found a “financial snake pit rife with greed, conflicts of interest, and wrong doing.”[20] And not just the Democratic Senator. His Republican counterpart was equally blunt. “Blame for this mess lies everywhere,” the ultra-conservative Tom Coburn said when sitting alongside Levin, “from federal regulators who cast a blind eye, Wall Street bankers who let greed run wild, and members of Congress who failed to provide oversight….It shows without a doubt the lack of ethics in some of our financial institutions who embraced known conflicts of interest to accomplish wealth for themselves, not caring about the outcome for their customers.”[21] Goldman Sachs (for their marketing practices), and Standard & Poor’s (for the inadequacy of their credit rating), were both heavily censored in the Levin report. The Subcommittee found no less than 12 Goldman Sachs’ practices that raised conflict of interests concerns: criticizing the company for designing, marketing and selling “CDOs in ways that created conflicts of interest with the firm’s clients and at times led to the bank’s profiting from the same products that caused substantial losses for its clients.”[22]

The logical outcome of these five unassailable truths would, in an entirely sane world, presumably be the extensive re-regulation of the entire financial sector and the punishment of the guilty among the financial elite; and there is some slow momentum building for at least a degree of punishment. Many of the main players have already slipped through the judicial net. Individuals like Angelo Mozilo, who agreed in October 2010 to pay $67.5 million to settle insider trading and other charges brought by the Securities and Exchange Commission.[23] Institutions like Citigroup, which paid $75 million in July 2010 to settle civil fraud charges filed by the SEC; or Goldman Sachs, who settled with the SEC that same month for $550 million.[24] (Two top Citigroup executives settled separately with the SEC that July, paying $100,000 and $80,000 respectively.[25]) But at last the net seems to be tightening slightly. The FDIC has reportedly filed suit to recover $900 million in damages from three former executives of Washington Mutual,[26] and is said to be conducting at least 50 criminal investigations of former senior figures in banks that have failed.[27] Carl Levin, for his part, has referred the evidence given to his subcommittee by Goldman Sachs executives (including by its CEO) to the Justice Department for possible criminal prosecution; Attorney Generals in Nevada and Arizona have filed suit against Bank of America for dubious lending procedures in the housing market; a coalition of 50 state attorney generals is gearing up to do the same; and New York’s Attorney General has called in documents on mortgage operations during the housing bubble from major financial institutions that include Bank of America and Morgan Stanley.[28]

However, don’t hold your breath. American justice grinds mighty slow when it is the mighty who are being called to justice. The initial anger – in Washington and beyond – against bank excess has now largely dissipated, and lobby spending by financial institutions has accordingly grown of late, as the battle over regulatory details has shifted away from Congress and back into the regulatory agencies themselves.[29]There was significant pushback against reform even before the passage of the Dodd-Frank Act [30] – pushback that left gaps in the new regulatory structures through which old forms of financial malpractice could and do continue to slip: pushback that ensured that there would be no impenetrable wall between commercial and investment banking, no watertight limit on the size of financial institutions, and an indeterminate amount of derivative trading still exempt from the new regulations.[31] (The formulation of those was left to the CFTC, where partisan infighting recently eroded the potency of the new regulatory codes still further[32]). Tighter regulation in the wake of the Act is accordingly proving more difficult than was originally hoped: partly due to the difficulty of getting Congressional clearance for Obama appointees, partly because of the sheer complexity of the practices being regulated, and partly because of resistance from large institutions and their lobbyists.

The new Republican majority in the House of Representatives is an additional thorn in the side of this tighter regulation: with the Tea Party-inspired legislators persistently underfunding (or attempting to defund) regulatory agencies, introducing bills to slow down or eviscerate the Dodd-Frank Act, and waging a particularly focused war on the new Consumer Financial Agency and its erstwhile head, Elizabeth Warren. Even the Obama administration is now apparently planning to exempt certain foreign exchange derivatives from regulations mandated by the Dodd-Frank Act.[33] Meanwhile, old practices are up and running again, as though they had made no contribution to our present malaise. The board of Citigroup awarded its CEO a base salary of $1.75 million for 2011. Bank of America paid its CEO $10.2 million in 2010, as JPMorgan Chase’s Jamie Dimon earned $23.6 million. Even the credit agencies, so defective in the run up to the crisis, are full of self-confidence again. Standard and Poor’s chose to warn in April of a potential downgrade to the credit rating of the United States, a downgrade directly linked to public borrowing made necessary by the recession that inadequate credit rating had helped trigger less than 3 years before! Standard & Poor’s, the very company on which in that same month the Levin-Coburn report had laid prime responsibility for triggering the financial meltdown (through their and Moody’s July 2007 mass downgrading of mortgage-backed securities hitherto rated AAA). It takes some nerve to be simultaneously so criticized and so critical, but Standard and Poor’s clearly have those kinds of nerves!

Richard Eskow complained in 2010 that “a banker can’t get arrested in this town.”[34] Well, perhaps it’s time that they could. In Iceland, in Germany and even in the UK, delinquent bankers occasionally end up in court, sometimes in jail, even expelled from the industry because of their malpractice. But not here, not this time, not yet (unlike in the earlier S&L crisis, when more than a thousand bankers were jailed [35]). As a whole string of commentators (including Richard Eskow, Matt Taibbi,[36] Les Leopold [37]and Joshua Holland [38]) have recently argued, it is surely time to call our bankers to account. Time because of justice; time because of the sufferings of others; time because only by calling delinquent bankers to account can we ever hope to prevent them dragging us all down again into a crisis and a recession of which we would be innocent, and which would be entirely of their making.

[30] For the detail, see Daniel Carpenter, “The Contest of Lobbies and Disciplines: Financial Politics and Regulatory Reform in the Obama Administration,” prepared for the Working Group on Obama’s Agenda and the Dynamics of U.S. Politics: now in Lawrence Jacobs and Theda Skocpol, eds, Reaching for a New Deal: President Obama’s Agenda and the Dynamics of U.S. Politics, (New York: Russell Sage Foundation, 2010).